European Financial Management 2020 Archive


January 2020, VOL 26:1 March 2020, VOL 26:2 June 2020, VOL 26:3

European Financial Management, VOL 26:1, January 2020


Limits‐to‐arbitrage, investment frictions, and the investment effect: New evidence


F. Y. Eric C. Lam, Ya Li, Wikrom Prombutr, K. C. John Wei


Abstract:
This study comprehensively reexamines the debate over behavioral and rational explanations for the investment effect in an updated sample. We closely follow the previous literature and provide several differences. Our tests include five prominent measures of corporate investment and corporate profitability in q‐theory and recent investment‐based asset pricing models. Both classical and Bayesian inferences show that limits‐to‐arbitrage tend to be supported by more evidence than investment frictions for all investment measures. When idiosyncratic volatility and cash flow volatility are used in measuring investment frictions, the inference is more favorable for the rational explanation.

Keywords: Limits-to-arbitrage; Investment frictions; q-theory; Investment, Stock returns


JEL Classification: G14, G31, G32, M41, M42



Director networks, turnover, and appointments


Luc Renneboog, Yang Zhao


Abstract:
This paper analyzes the labor market (turnover and appointments) of executive and non-executive directors by means of social network methodology. We find that directors with strong networks are able to obtain labor market information that enables them to leave their firm more easily for better opportunities. Networks also mitigate information asymmetry problems of external director appointments. Furthermore, the strong impact of indirect connections is in line with the ‘strength of the weak ties’ theory. The fact that direct connections are less important signifies that the connections to people that are close and local are likely to convey redundant information, whereas connections to distant individuals are more efficient in terms of information acquisition and labor market performance improvement.

Keywords: Corporate Governance; Director Networks; Director Turnover; Director


JEL Classification: G34, J4, L14



Corporate social responsibility: An umbrella or a puddle on a rainy day? Evidence surrounding corporate financial misconduct


John Bae, Wonik Choi, Jongha Lim


Abstract:
We examine the way a fraudulent firm's pre‐ and post‐misconduct corporate social responsibility engagement is associated with its stock performance to investigate the reputational role of corporate social responsibility (CSR). In the short term, firms with good CSR performance suffer smaller market penalties upon the revelation of financial wrongdoing, supporting the buffer effect, as opposed to the backfire effect, of a good social image. We also find that the misbehaving firms’ post‐misconduct CSR efforts are negatively associated with delisting probabilities, and positively with stock returns. These findings support the argument that increasing post‐crisis CSR engagement can be an effective remedy for a damaged reputation

Keywords: TBA


JEL Classification: TBA



NAV inflation and impact on performance in China


Mark Shackleton, Jiali Yan, Yaqiong Yao


Abstract:
Our study is among the first to examine the net asset value (NAV) inflation practices of fund managers in China, finding that equity funds bolster their portfolios at quarter‐end and especially year‐end. In support of the NAV inflation hypothesis in China, we further document the following: (1) NAV inflation is more profound for the worst‐performing fund managers; and (2) the stocks in which fund managers hold larger stakes exhibit a more marked pattern of price inflation around quarter‐ and year‐ends than do other stocks. We also find that closed‐end funds in China engage in NAV inflation at quarter‐ and year‐ends.

Keywords:TBA


JEL Classification: TBA



Bank liquidity, macroeconomic risk, and bank risk: Evidence from the Financial Services Modernization Act


I‐Ju Chen, Yu‐Yi Lee, Yong‐Chin Liu


Abstract:
We investigate the empirical relationship between macroeconomic risk, bank liquidity, and bank risk surrounding the 1999 Financial Services Modernization Act. We propose that bank risk and liquidity are positively related as macroeconomic risk increases, and that this effect is particularly strong after the Gramm–Leach–Bliley Act (GLBA). We test our hypotheses by collecting data from 1994 to 2006 for banks in the United States. The results show that banks flush with liquid assets in a high macroeconomic risk environment conducted more lending activities following the enactment of the GLBA, leading to higher bank risk. Our study complements the understanding of bank liquidity management.


Keywords: TBA


JEL Classification: TBA



Manager skill and portfolio size with respect to a benchmark


Andrei Bolshakov, Ludwig B. Chincarini


Abstract:
Investment managers often manage a portfolio with respect to a benchmark. Typ- ically, they use a mean-variance optimization framework to maximize the information ratio of their portfolio. We develop an unconventional approach to this question. Given a set of assumptions, we ask what optimal percentage of the benchmark stocks should the portfolio manager select. This optimal portfolio depends on Fisher’s and Walle- nius’s noncentral hypergeometric distribution. We find that the optimal selectivity of a benchmark universe varies from 50% to 80%. These results are provocative, given that many enhanced index portfolio managers select a low percentage of the benchmark universe.


Keywords: Enhanced indexing, information ratio, portfolio management, active man- agement.


JEL Classification: G0, G13



Does trade credit really help relieving financial constraints?


Stefania Cosci, Roberto Guida, Valentina Meliciani


Abstract:
The European Union introduced a directive aimed at reducing trade credit due to its supposedly negative effect on the European economy. This contrasts with the redistribution view arguing that trade credit could facilitate the financing of credit-constrained firms by more liquid suppliers. But does trade credit mainly flow from relatively unconstrained suppliers to more financially constrained buyers? To answer this question, we look at the characteristics of net borrowers with respect to net lenders and then estimate the substitutability between trade and bank debt separately for the two groups of firms. Overall, the results show that, in Italy, efficient redistribution does not tend to prevail in the trade credit market


Keywords: Trade credit; redistribution view; financial constraints; substitutability.


JEL Classification: G32; G21; D82



Second and higher moments of fundamentals: A literature review


Yuecheng Jia, Ivilina Popova, Betty Simkins, Qin Emma Wang


Abstract:
This literature review outlines the recent progress in fundamental second and higher moments research. We survey the moments’ existence, formation, and financial market andmacroeconomic implications. Research shows that time-varying volatility and non-Gaussian shocks exist throughout all measures of fundamentals at both the micro and macro levels.Additionally, the granular network among firms helps explain the origin of fundamental second and higher moments. Empirical evidence shows that the moments have strong predictive power on asset prices and macroeconomic variables. We also highlight several areas wheremore research is needed to better understand the moments.


Keywords:Fundamental second moments, Fundamental higher moments, time-varying volatility, non-Gaussian shocks, granular network


JEL Classification: G12



Uncovering Predictability in the Evolution of the WTI Oil Futures Curve


Fearghal Kearney, Han Lin Shang


Abstract:
Accurately forecasting the price of oil, the world’s most actively traded commodity, is of great importance to both academics and practitioners. We contribute by proposing a functional time series based method to model and forecast oil futures. Our approach boasts a number of theoretical and practical advantages including effectively exploiting underlying process dynamics missed by classical discrete approaches. We evaluate the finite-sample performance against established benchmarks using a model confidence set test. A realistic out-of-sample exercise provides strong support for the adoption of our approach with it residing in the superior set of models in all considered instances.


Keywords: Crude oil, Forecasting, Functional time series, Futures contracts, Futures markets


JEL Classification: G10, G15, C53




European Financial Management, VOL 26:2, March 2020


News sentiment and sovereign credit risk


Lara Cathcart, Nina M. Gotthelf, Matthias Uhl, Yining Shi


Abstract:
We explore the impact of media content on sovereign credit risk. Our measure of media tone is extracted from the Thomson Reuters News Analytics database. As a proxy for sovereign credit risk we consider credit default swap (CDS) spreads, which are decomposed into their risk premium and default risk components. We find that media tone explains and predicts CDS returns and is a mixture of noise and information. Its effect on risk premium induces a temporary change in investors’ appetite for credit risk exposure, whereas its impact on the default component leads to reassessments of the fundamentals of sovereign economies.

Keywords: CDS, sovereign risk, credit risk premium, media tone


JEL Classification: G12; G15.



Do security breaches matter? The shareholder puzzle


Allen Michel, Jacob Oded, Israel Shaked


Abstract:
This article analyzes the effect of computer breaches on publicly traded equities from 2005 to 2017. An event study is performed and breaches analyzed conditioned on whether the breach announcement has been made in the mainstream media or through other channels. We find that in the period prior to the announcement date in the media, the mean abnormal return is negative, reflecting a likely leakage of information. In the period following the announcement date, the mean abnormal return is positive, often more than offsetting the previous declines. The findings have important implications for analysts, portfolio managers, institutional investors, and regulators.

Keywords:


JEL Classification:



Downside beta and the cross section of equity returns: A decade later


Yigit Atilgan, K. Ozgur Demirtas, A. Doruk Gunaydin


Abstract:
This study reexamines the relation between downside beta and equity returns in the U.S. First, we replicate Ang, Chen and Xing (2006) who find a positive relation between downside beta and future equity returns for equal-weighted portfolios of NYSE stocks. We show that this relation doesn’t hold after using value-weighted returns or controlling for various return determinants. We also extend the original sample, add AMEX/NASDAQ stocks or utilize alternative downside beta measures and still find no downside risk premium. We focus on factor analysis results, persistence of downside beta and various subsamples to understand the economic reasons behind the findings.

Keywords:downside beta, downside risk, tail risk, equity returns, asset pricing


JEL Classification: G10, G11, G12



Motivated monitoring by institutional investors and firm investment efficiency


Charles Ward, Chao Yin, Yeqin Zeng


Abstract:
We find that motivated monitoring by institutional investors mitigates firm in- vestment inefficiency, estimated by Richardson’s (2006) approach. This relation is robust when using the annual reconstitution of the Russell indexes as exogenous shocks to institutional ownership during the period 1995–2015 and after classifying institutional ownership by institution type. We also show that closer monitoring mitigates the problem of both over-investing free cash flows and under-investment due to managers’ career concerns. Finally, we document that the effectiveness of the monitoring by institutional investors appears to increase monotonically with respect to the firm’s relative importance in their portfolios.

Keywords:Institutional investors; Investment efficiency; Monitoring attention; Agency problem; Index switch


JEL Classification: G23; G30; G31; M4



Cash holdings in family firms: CEO identity and implications for firm value


Lorenzo Caprio, Alfonso Del Giudice, Andrea Signori


Abstract:
We investigate the cash holdings policy of family firms and examine potential value implications. Family firms hold more cash than other firms, with an average difference of 2.3% of total assets. This result is driven by firms managed by heir CEOs. While the cash holdings policy of first-generation family firms is more sensitive to firm risk, consistent with founders’ increased risk aversion, that of later-generation firms is more sensitive to information asymmetry and agency conflicts. Heir CEOs’ cash policies destroy value, as the marginal value of an additional euro suffers from a 38.3-cent discount, on average, relative to non-family firms.

Keywords:cash holdings, family firms, value of cash, family generation


JEL Classification: G30; G32; G35



Board diversity reforms: Do they matter for EU bank performance?


Francesca Arnaboldi, Barbara Casu, Elena Kalotychou, Anna Sarkisyan


Abstract:
We examine the impact of governance reforms related to board diversity on the performance of European Union banks. Using a difference‐in‐difference approach, we document that reforms increase bank stock returns and their volatility within the first 3 years after their enactment. The type of reform matters, with quotas increasing return volatility. The effectiveness of reforms depends on a country’sinstitutionalenvironment.Theimpactofreforms on return volatility is found to be beneficial in countries moreopentodiversity, withcommonlaw system and with greater economic freedom. Finally, reforms play a bigger role in banks that have ex ante less heterogeneous boards.

Keywords:bank performance, board diversity reforms, corporate governance codes


JEL Classification: G21; G30



When fund management skill is more valuable?


Feng Dong, John A. Doukas


Abstract:
Does fund management skill allow managers to identify mispriced securities more accurately and thereby make better portfolio choices resulting in superior fund performance when noise trading – a natural setting to detect skill – is more prevalent? We find skilled fund managers with superior past performance to generate persistent excess risk‐adjusted returns and experience significant capital inflows, especially in high sentiment times, high stock dispersion, and economic expansion states when price signals are noisier. This pattern persists after we control for lucky bias, using the ‘false discovery rate’ approach, which permits disentangling manager ‘skill’ from ‘luck.’

Keywords:


JEL Classification:



Intra‐industry bankruptcy contagion: Evidence from the pricing of industry recovery rates


Yuanchen Chang, Yi‐Ting Hsieh, Wenchien Liu, Peter Miu


Abstract:
How does bankruptcy contagion propagate among industry peers? We study the debt recovery channel of industry contagion by examining whether the cost of a company’s debt is affected by the observed recovery rates of its bankrupt industry peers. Our results show that lower industry recovery rates are associated with higher loan spreads, but only when the contracts were originated during industry bankruptcy waves. Consistent with the debt recovery channel of industry contagion, we find that the negative effects of industry recovery rates are significantly stronger under situations where the effect is expected to be more salient..

Keywords: Industry contagion, Recovery rate, Loan pricing, Debt recovery channel


JEL Classification: G30, G33.




European Financial Management, VOL 26:3, June 2020


Forecasting Recoveries in Debt Collection: Debt Collectors and Information Production

Johannes Kriebel and Kevin Yam


Abstract:
Recent theoretical work suggests that debt collection agencies play an important role in gathering and processing debt or information. We study a comprehensive data set with information provided by original creditors and information gathered in third-party debt collection. In line with the theoretical results, the initial information is sparse and the gathered information is essential for better-informed predictions.


Keywords: Loss given default, recovery rate, debt collection.


JEL Classification: G21, G22, G29, G3



Ownership Ties, Conflict of Interest, and the Tone of News


Emanuele Bajo, Marco Bigelli, Carlo Raimondo


Abstract:
This paper investigates the tone newspapers use in reporting information on a company that is linked with through an ownership tie. Our empirical setting is Italy, a country characterized by dominant national industrial groups’ high ownership of newspapers. Based on a sample of about 123,000 articles, we document that newspapers’ coverage of firms in conflict of interest is greater, with significantly fewer negative and uncertain words. We also document that the slant increases with ownership stakes and decreases with the newspaper’s reputation.


Keywords: Media; ownership structure; conflict of interest.


JEL Classification: G32; L26




Idiosyncratic Momentum and the Cross-Section of Stock Returns: New Evidence

Qi Lin


Abstract:
In this paper, we evaluate the profitability and economic source of the predictive power of the idiosyncratic momentum effect, by using five popular factor models to construct idiosyncratic momentum. We show that all five idiosyncratic momentum strategies produce similar return predictability and consistently outperform the conventional momentum strategy in the cross-sectional pricing of equity portfolios and individual stocks. This positive effect of idiosyncratic momentum on returns is consistent with the investment capital asset pricing model (CAPM). Further analysis reveals that the firm-level idiosyncratic momentum effect cannot extend to the aggregate stock market.


Keywords:Idiosyncratic momentum, Asset pricing, The investment CAPM, Market return predictability


JEL Classification:


G11, G12, G17

Credit Risk, Owner Liability and Bank Loan Maturities During the Global Financial Crisis

Fabio Dias Duarte, Ana Paula Matias Gama and Mohamed Azzim Gulamhussen


Abstract:
We relate credit risk and owners’ personal guarantees to bank loan maturities during the global financial crisis. The findings, which remain robust to reverse causality, show that firms rated as low risk, with a strong relationship with the bank, whose owners provided personal guarantees and with large loan sizes obtained longer maturities. Banks with larger nonperforming loans provided loans with shorter maturities. Firms with low and high risk ratings that provided owners’ personal guarantees obtained longer maturities. These findings shed additional light on the relationship between risk and loan maturities and the role of personal guarantees in reducing information asymmetries.


Keywords: : Small firm financing; Financial crisis; Government policy and regulation; Banks


JEL Classification: D82; G01; G18; G20



Do Bankers on the Board Reduce Crash Risk?

Min Jung Kang, Y. Han (Andy) Kim and Qunfeng Liao


Abstract:
Commercial banker-directors (CBDs) bring both financial expertise in risk management and conflicts of interest between shareholders and debtholders. The burgeoning literature on stock price crash risk generates important questions of whether CBDs reduce crash risk. Using BoardEx data from 1999 to 2009, we find supporting evidence that the firms with CBDs experience lower stock price crash risk. Moreover, the reduction of crash risk is more pronounced for high-risk firms under the monitoring of affiliated banker-directors (ABDs). The results of this study are robust to the Heckman selection model, propensity score matching, and alternative measures of crash risk.


Keywords: banker-directors, crash risk, agency cost, corporate governance, firm risk


JEL Classification: G14, G30, M40



Does Market Power Discipline CEO Power? An Agency Perspective

Anutchanat Jaroenjitrkam, Chia-Feng (Jeffrey) Yu, and Ralf Zurbruegg.


Abstract:
We examine how product market competition (PMC) shapes CEO power. Using various measures to capture both PMC and CEO power, our analyses, which includes a quasi-natural experiment, finds evidence that CEOs have less power when the product market is more competitive. Furthermore, the impact of PMC on CEO power is more pronounced for firms where management are entrenched, where there is lower CEO ownership and lower analyst coverage, and for firms experiencing good “luck” (windfall performance). Our results suggest that market power can act as a substitute for corporate governance in disciplining CEO power, particularly when prone to agency problems.


Keywords: CEO power, market competition, corporate governance, luck


JEL Classification: D22, G34, M52



Social Media Bots and Stock Markets

Rui Fan, Oleksandr Talavera, and Vu Tran


Abstract:
This study examines the link between information spread by social media bots and stock trading. Based on a large sample of tweets mentioning 55 companies in the FTSE 100 composites, we find significant relations between bot tweets and stock returns, volatility, and trading volume at both daily and intraday levels. These results are also confirmed by an event study of stock response following abnormal increases in tweets volume. The findings are robust to various specifications including controlling for traditional news channel, alternative measures of volatility, information flows in pre-trading hours, and different measures of sentiment.


Keywords: Social media bots, investor sentiment, noise traders, text classification, computational linguistics


JEL Classification: G12, G14, L86



Consumption, Asset Wealth, Equity Premium, Term Spread and Flight to Quality

Mauro Costantini and Ricardo Sousa


Abstract:
We link transitory deviations of consumption from its equilibrium relationship with aggregate wealth and labor income and: i) equity returns; and two characteristics of bond investors, ii) the premium demanded to hold long-term assets; and iii) the “flight to quality” behavior. Using a panel of 10 euro area countries over the period 1984Q1-2017Q4, we show that a rise in the consumption-wealth ratio predicts both higher equity returns and the future term spread, while a fall in the consumption-wealth ratio explains a large fraction of the rise in the spread between the “risky” and the “safe-haven” bond.


Keywords: consumption, asset wealth, labor income, term premium, flight to quality, panel data


JEL Classification: C33, E21, E44, D12.



Does Individualistic Culture Impact Operational Risk?

Zhe (Andrew) An, Zhe Cao, Zhian Chen and Donghui Li


Abstract:
Employing a sample of 2957 operational-risk events across 31 countries from 1990 to 2011, we find that financial institutions located in countries with higher individualism tend to have higher operational risk. This positive relation is achieved through the risk-taking channel and the earnings-management channel. In addition, the magnitude of operational losses is higher in more individualistic countries. The results suggest that individualism serves as an important informal institutional determinant of operational risk in an international context. Endogeneity tests and various robustness checks confirm our findings.


Keywords: Operational Risk, Individualism, National Culture


JEL Classification: G20, G32, G15